Taxation Ruling No. IT 2540

IT 2540

Please note that the PDF version is the authorised version of this ruling.

This ruling contains references to repealed provisions, some of which may have been rewritten. The ruling still has effect. Paragraph 32 in TR 2006/10 provides further guidance on the status and binding effect of public rulings where the law has been repealed or repealed and rewritten. The legislative references at the end of the ruling indicate the repealed provisions and, where applicable, the rewritten provisions.

FOI status: May be released

PREAMBLE

This Ruling discusses the operation of the capital gains and losses provisions, Part IIIA of the Income Tax Assessment Act 1936 ('the Act'), in relation to partnerships. In particular, the Ruling discusses the application of the capital gains and capital losses provisions to disposals of partnership assets and to dealings by partners in relation to the interest they hold in the partnership.

RULING

Basis of application of Part IIIA to partnership assets

2. Under general law in relation to partnerships, a
partnership is not a separate legal entity distinct from the individual
partners who comprise the partnership. Accordingly, the partnership
does not own property in its own right; title to the partnership assets
is legally vested in the partners, even though an individual partner may
have no separate title to specific partnership assets. This view
accords with the opinion expressed by the majority (Barwick CJ.,
Stephen, Mason and Wilson JJ.) of the Full High Court of Australia in
F.C.T. v. Everett (1980) 143 CLR 440 at page 446 :

"Although a partner has no title to specific property owned by
the partnership, he has a beneficial interest in the partnership assets,
indeed in each and every asset of the partnership."

That
case concerned the assignment by a partner of part of his interest in a
partnership and, in the context of discussing the nature of the
assignee's interest in the partnership, the majority went on to say, at
p.448 :

"What is more, legal title to the assets of the partnership
continues to vest in the partners to the exclusion of the assignee and
he has no access to the assets."

3. The agreement between the partners may vary the terms
by which legal ownership of the partnership assets is allocated between
partners, for example, an individual partner may be the owner of all the
partnership assets to the exclusion of other partners whose entitlement
relates only to the income of the partnership. However, that position
is merely a corollary of the general principle that ownership of the
partnership assets is not vested in the partnership itself.

4. It has been suggested that Part IIIA may apply to a
partnership even though the partnership cannot own assets. This is
based on the fact that a partnership is treated as if it were a separate
entity for certain income tax purposes. However, in its application,
Part IIIA variously refers to a person who owns an asset (for example,
in sections 160C, 160L and 160M). It is considered that the structure
of Part IIIA leads to the conclusion that a net capital gain or net
capital loss does not accrue to, or is not incurred by, a partnership.
In terms of Part IIIA partnership assets are not owned by the
partnership, but rather by the individual partners, hence any gain or
loss on disposal accrues to, or is incurred by, the individual partners
who owned the assets.

5. Of course there are specific provisions in the Act,
Division 5 of Part III, which deal exclusively with partnerships. The
provisions of Division 5 establish the rules for income tax purposes by
which a partner's interest in the assessable income of a partnership is
determined. Subsection 92(1) provides, inter alia, that the assessable
income of a partner includes an interest in the "net income" of the
partnership of the year of income. "Net income" is defined by section
90 to mean, in effect, an amount equal to the assessable income of the
partnership, calculated as if the partnership were a taxpayer, less all
deductions other than concessional deductions, carry-forward losses,
etc. Corresponding provisions in subsection 92(2) determine a deduction
allowable to a partner for a partnership loss.

6. While section 160ZO of the Act requires a net capital
gain to be included in the assessable income of a taxpayer, it does so
only once the net capital gain has first accrued to the taxpayer. As
indicated in the preceding paragraphs, it is considered that no such
gain can accrue to a partnership. Therefore, even though the partnership
itself is treated as a taxpayer for purposes of calculating the "net
income" of the partnership, that "net income" does not include a net
capital gain on the disposal of a partnership asset. Similarly, a
capital loss determined under paragraph 160Z(1)(c) in respect of the
disposal of a partnership asset is not a partnership loss; rather, the
loss is incurred by the partners in their own right.

7. Division 5 of Part III determines the nature of a
partner's interest in the net income of the partnership of which he or
she is a member and his or her interest in a partnership loss for the
purposes of the Act. The Division does not override the general
principle that the partnership itself is not a separate entity and does
not own assets. These conclusions are consistent with the views
expressed by Stephen J. in Tikva Investments Pty Ltd v. F.C.OF T. (1972)
128 CLR 158 at p.168 :

"If then, when Tikva became a member, a new association of
persons came into being it is of that new association that s.90 speaks
when it refers to assessable income of a partnership being calculated as
if the partnership were a taxpayer; for the purpose of calculation of
assessable income, but for that purpose only, a new taxpayer is brought
into existence. For all other relevant purposes, it is with the
individual members that the Act is concerned. It follows...that the Act
effects no general departure from the ordinary position in English law
according to which a partnership is not a separate legal entity,
distinct from the members composing it."

Practical issues

8. There are two broad circumstances that need to be
considered in relation to the application of Part IIIA at the partner
level on the disposal of partnership assets. The first is the
application of the Part on the disposal of a partner's interest in the
partnership, whether in whole or in part. The second issue concerns the
consequences, in terms of Part IIIA, for the individual partners who
have an interest in the assets of the partnership where there is a
disposal of one or more of those assets.

(1) Disposal by a partner of an interest in the partnership
assets on the disposal of a partnership interest

9. On the acquisition or disposal of a partnership
interest it will be necessary for a partner to account for his or her
interest in the partnership assets. The disposal of the partnership
interest generally means that there is a disposal of the partner's
interest in each of the individual partnership assets. Subject to what
follows, in order to determine any capital gain or capital loss to the
partner in respect of his or her interest in each of the assets, it will
be necessary to determine the portion of the disposal proceeds
attributable to each of those interests. Similarly, on the acquisition
of a partnership interest, the consideration paid should be apportioned
to the interests in each of the partnership assets acquired, so that on
their subsequent disposal, the capital gain or capital loss to the
partner can be determined.

10. A partner's interest in the partnership and in the
partnership assets may change from time to time. This could occur on
the admission to, or retirement from, the partnership of any of the
partners. To the extent that a partner's original interest has changed,
there may have been a part disposal of his or her interests in the
partnership assets (for instance, where there is an admission of a new
member to the partnership) or the partner may have acquired additional
interests in the partnership assets (for example, where another partner
retires from the partnership). Thus, although a partner's original
interest may have been acquired prior to 20 September 1985, the partner
may have acquired new interests in assets since that date. Therefore,
at the time of disposal of his or her partnership interest or of
particular partnership assets, the partner may be disposing of assets
acquired before 20 September 1985 and other assets acquired (partly or
wholly) on or after that date. This follows from the central theme of
this Ruling, that is, in looking at the disposal of a partnership
interest or a partnership asset, Part IIIA applies to the individual
partner on the basis of what asset that partner owns, the date on which
the partner acquired the asset and any consideration given in respect of
its acquisition.

11. It should be noted that for the purposes of the
capital gains tax provisions the retirement or admission of a partner
does not necessarily affect the other partners' continuing interests in
the partnership assets or in the partnership as a whole. The continuing
interest means that part of the interest in each of the partnership
assets and the partnership itself which a partner has after the
admission or retirement and which the partner also had before the
admission or retirement.

12. In cases where the number of partners in a
partnership is small, the cost base and acquisition date of a relevant
partner's interests in the partnership assets should be able to be
determined without undue difficulty.

13. For large partnerships, which can have memberships
numbering in the hundreds (for example, some major legal and accountancy
partnerships) the situation is potentially more complex. In some cases,
the potential problems are overcome because the ownership of the assets
used by the partnership is vested in a service company or trust. In
other cases, it will generally be accepted, provided the evidence
reasonably supports the conclusion, that the partners are dealing with
each other at arm's length. Any consideration paid or received on the
acquisition or disposal of an interest in the partnership will be used
for Part IIIA purposes in determining the cost base or disposal proceeds
of the interests in the partnership assets that the partnership interest
represents. This will mean that if, for example, the partnership
arrangement is such that no amount is payable for the acquisition or
disposal of goodwill, it will be accepted for the purposes of Part IIIA
that the value of the goodwill is nil. This treatment will also apply to
partners of smaller partnerships who deal with each other at arm's
length, where those dealings take place in an ordinary commercial
context.

14. In the case of large professional partnerships, where
the partners' dealings with each other are at arm's length, it will only
be where consideration is paid by a partner on entering the partnership
or where a partner receives a payment on leaving the partnership that
Part IIIA will have any practical effect. Where consideration is neither
paid by a person on entering the partnership, nor received on retirement
from the partnership, the partner will not realise a capital gain or
incur a capital loss on the disposal of particular assets. However, as
noted above, the admission or retirement of a partner may affect the
proportionate ownership of the partnership assets by the individual
partners and therefore may affect the extent of a continuing partner's
interest in the partnership. This would be relevant in the event of a
subsequent disposal of the partnership assets for consideration, or
where consideration is paid to a partner on retirement from the
partnership.

15. Where a partner has interests in the partnership
assets which were acquired on or before 19 September 1985 and also after
that date, on a subsequent disposal of an interest in the partnership
assets, for example, on the admission of a new member to the
partnership, where identification of the actual asset disposed of is not
possible it will be open to the partner to decide which of those
interests in the partnership assets he or she is disposing of.

16. In the case of a merger of two or more partnerships
there is no departure from the general rules contained in Part IIIA
relating to the acquisition and disposal of assets and the treatment of
non-cash consideration; each partner disposes of some of his or her
existing interests in the partnership assets and acquires new interests
in other assets. In applying Part IIIA, paragraphs 160ZH(4)(b) and
160ZD(1)(b), have the effect that the market value of property given or
received on the acquisition or disposal of an asset is the consideration
in respect of that acquisition or disposal.

(2) Disposal of partnership asset

17. The other issue to be addressed in this Ruling
relating to the disposal of interests in partnership assets concerns the
effect for the individual partners of the disposal of a particular
partnership asset. The matter is particularly relevant in the
circumstances of large partnerships (not using a service company or
service trust structure) where gains or losses are realised or incurred
on the disposal of partnership assets.

18. Where there is a disposal of a partnership asset to
a third party, each of the partners disposes of his or her fractional
interest in the asset. For example, take the situation where a
partnership comprised of 10 partners disposes of a block of land for
$150,000 which was originally purchased for $90,000. In this case, each
partner is taken to have disposed of his or her interest in the land;
however, individual partners may have acquired their interests at
different times (for example, some may have done so before 20 September
1985 and others on or after that date) and may have paid different
amounts as consideration for the acquisition of those interests. If the
partners own equal interests in the land, each will be taken as
receiving $15,000 as disposal proceeds. If the land had been acquired
after 19 September 1985, each member who was a partner at the time of
acquisition would have a cost base of $9,000 in respect of the
acquisition of his or her interest in the land, and the capital gain
would be calculated on that basis. If another partner entered the
partnership after the acquisition of the land and paid $12,000 for his
or her interest in the land, that partner would have a cost base of
$12,000 and would therefore realise a capital gain of $3,000 (subject to
indexation) on the disposal.

19. Again, the interest of an individual partner in an
asset may have changed since it was originally acquired, for example, by
the admission or retirement of partners. In addition, if the asset was
acquired before 20 September 1985, but admissions or retirements to the
partnership have since occurred, an individual partner's interest in the
asset may have changed and a proportion of that interest may have a
post-19 September 1985 acquisition date. To illustrate, take the
example in the preceding paragraph but assume the land was acquired by
the partnership, comprised of the 10 partners, before 20 September 1985.
If there were no change in the composition of the partnership, when the
land was subsequently sold there would be no capital gain or loss to any
of the partners - each partner's interest in the partnership asset
having been acquired prior to the commencement of Part IIIA. However,
if one of the partners retired after 19 September 1985 and the remaining
9 partners acquired a proportion of the retiring partner's interest in
the land for $1,000, although the retiring partner has no capital gains
tax consequences, the other partners have each acquired a new post-19
September 1985 interest in the asset, i.e., one-ninth of the retiring
partner's 10 per cent interest in the land. On the subsequent sale of
the block of land for $150,000, assuming there have been no other
changes, each partner would realise a capital gain (again subject to
indexation) in respect of that new interest. While this example deals
with the retirement of a partner, similar types of adjustment will be
required where a new partner is admitted to a partnership.

20. Where there has been a change in the interests of the
individual partners in an asset since its acquisition, the onus rests on
each partner to determine any capital gain or capital loss on the
disposal of his or her interest in that asset. To calculate that gain
or loss the partner would need to have regard to various factors,
including the acquisition date of the asset disposed of, the acquisition
date of the partner's interest in the partnership, any costs
attributable to the asset's acquisition and any changes in the
membership of the partnership which affect the partner's
interest.

21. In the case of large professional partnerships the
question has also arisen whether, in circumstances where a partnership
asset which is subject to depreciation allowances is sold, the
individual partners must each account for the disposal in their
individual returns. In view of the practical difficulties which could
otherwise result, it has been decided that where a depreciable
partnership asset is disposed of and no capital gain arises on the
disposal of the asset to any of the partners, the individual partners
are not required to disclose the disposal of the asset in their
individual returns. In line with the existing practice in relation to
depreciable partnership assets, the disposal may be accounted for in the
partnership return.

"Everett" Assignments

22. A further question that arises in relation to the
application of Part IIIA to partnerships concerns what are referred to
as "Everett" assignments; that is, where a partner in a partnership
assigns part of his or her partnership interest in a similar situation
to that before the High Court in F.C. of T. v. Everett (1980) 143 CLR
440. The issues that arise in relation to an Everett assignment for the
purposes of applying Part IIIA concern the nature of the asset disposed
of and the consideration that is attributable to its disposal.

23. Everett's case concerned the correct taxation
treatment of partnership income where a partner assigned part of his
share in a partnership to his wife. The case did not specifically deal
with the nature of the assignee's (i.e., the wife's) interest in the
partnership. However, it is clear that the decision of the majority of
the High Court - that the share of the partnership income attributable
to the assigned partnership interest was assessable to the assignee -
was founded on the premise that the effect of the assignment was to
confer an immediate interest in the partnership to the assignee. At
p.452, the majority said :

"The consequence in the present case is that because the
respondent assigned present property, a chose in action, being a share
of his interest in the partnership which carried with it the right to a
proportionate share of future income attributable to his interest, the
assignment became effective at once and conferred on his wife an
immediate equitable entitlement as against the respondent and the other
partners to such income referable to the share assigned as might
subsequently be derived. This case is to be distinguished from .........
other cases in which there have been assignments of future income
dissociated from the property or proprietary right to which that income
is attributable."

24. For the purposes of Part IIIA, it is considered that
the effect of an Everett assignment is that the partner disposes of part
of his or her partnership interest, notwithstanding that the assignee
only has an equitable interest in the assignor's partnership interest
and that legal title to the partnership assets continues to vest in the
partners to the exclusion of the assignee (see Everett's case at p.448).
In line with the discussion earlier in this Ruling, the assignment of
part of the partnership interest will be treated as a part disposal of
the partner's interests in the partnership assets.

25. It would be very unusual for an Everett assignment to
be made on an arm's length basis. Therefore, by the operation of
subsection 160ZD(2), the consideration for the disposal of those
interests in the partnership assets (that occurs as a result of the
assignment of the partnership interest) will, for capital gains tax
purposes, be their market value.

26. However, in considering the consequences in terms of
Part IIIA of an Everett assignment, it is also necessary to consider the
decision of Burt CJ. of the Supreme Court of Western Australia in
Reynolds v. Commissioner of State Taxation (WA) 86 ATC 4528, 17 ATR 987.
Reynolds' case involved the valuation of an assigned partnership
interest, the valuation being necessary in order to determine the stamp
duty payable on the transfer of the partnership interest. It is
significant that in Reynolds' case the assets used by the partnership
were owned by an administration company and a service trust, so that the
assignment of the partnership interest conferred no interest in those
assets. The members of the partnership also did not recognise any value
for goodwill.

27. Notwithstanding this, Burt CJ. decided that the
assigned partnership interest was of value; its value derived from the
value of the right that was attached to the partnership interest to
receive a proportionate share of the future income of the partnership.
That right was conferred on the assignee on the assignment of the
partnership interest.

28. Where an Everett assignment is not made at arm's
length, the valuation method adopted in Reynolds' case will usually be
the appropriate method for determining the market value of the assigned
partnership interest for the purposes of Part IIIA. Broadly, this will
involve the determination of the price that a "hypothetical buyer" would
pay for the assigned partnership interest having regard to the value of
the right to the future income of the partnership which is attached to
the interest.

29. As discussed in paragraphs 24 and 25, where the
assets used by the partnership are owned by the partners rather than a
service company or service trust, the assignment will also result in a
part disposal of the partner's interests in those assets for
consideration equal to their market value.

30. It is accepted that the partners in a professional
partnership will usually deal with each other at arm's length.
Therefore, in considering the application of Part IIIA to the disposal
of a partnership interest by way of an Everett assignment, the cost base
will be the consideration given by the partner to acquire the
partnership interest. This will include the amount paid for the
acquisition of any interests in the partnership assets that are disposed
of by the assignment. For the purposes of the capital gains provisions,
consideration for the acquisition of an asset is limited, by subsection
160ZH(4), to money paid or property given for the acquisition of the
asset.

Section 160ZZS

31. Section 160ZZS applies to an asset acquired by a
taxpayer before 20 September 1985 where there has been a change in the
majority underlying interests in the asset since that date, to deem the
asset to have been acquired after 19 September 1985. In the case of a
partnership asset, section 160ZZS does not apply because, as stated in
this Ruling, each partner owns an interest in each of the partnership
assets and Part IIIA applies on the disposal of those interests. The
only potential application of section 160ZZS to a partnership asset is
indirect; for example, where a partner in the partnership is a company,
majority underlying interests in which have changed since 19 September
1985.